Wash Sale Losses

Many tax preparers and taxpayers struggle with wash sale loss rules

WASH-SALE LOSS RULES

Per IRS Publication 550: “A wash sale occurs when you (a taxpayer) sell or trade stock or securities at a loss and within 30 days before or after the sale you:

  • Buy substantially identical stock or securities,
  • Acquire substantially identical stock or securities in a fully taxable trade,
  • Acquire a contract or option to buy substantially identical stock or securities, or
  • Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.”

WASH SALES REPORTED ON 1099-B

Broker 1099-Bs report “wash sale loss disallowed” (box 1g), and it’s not uncommon to see an enormous amount for an active securities trader. The 1099-B also reports “proceeds” (box 1d), “cost or other basis” (box 1e), and several other related amounts. For example, $10M proceeds minus $9.9M cost or other basis, plus $150,000 of wash-sale loss disallowed, equals $250,000 taxable capital gains. The 1099-B cover page has summary numbers, and supplemental schedules include each securities trade for the previously summarized numbers.

The essential point is that WS loss disallowed in box 1g is for the entire tax year. However, WS losses deferred at year-end cause phantom income in the current tax year. Many WS losses during the year might fade away by year-end (more on this later). Unfortunately, brokers do not report WS losses deferred at year-end, and clients need that information. If a trader uses trade accounting software, he needs the amounts deferred by ticker from one year to the next to continue to track the deferred amount and deduct it in the following year when calculations allow the release of the loss.

For example, two traders can have $1M of WS loss disallowed in box 1g. Trader A doesn’t have WS losses at year-end, and she is not concerned with those adjustments during the year. She sold all open positions by year-end and did not repurchase substantially identical positions in January. Trader B also sold all positions by year-end, but he made repurchase trades in January, triggering $50,000 of WS losses deferred at year-end. Trader B delayed the December WS loss to the subsequent tax year. The 1099B issued to Trader B by the brokerage firm will not specify the $50,000 loss is deferred so that the loss will be lumped in the wash-sale loss adjustment total for the entire year.

Traders need ongoing WS loss information throughout the year to prevent this predicament. Some monthly brokerage statements include cost basis amounts for month-end open positions listed on the report, and other monthly brokerage statements do not.

Most traders don’t realize they have a WS loss problem until they receive 1099-Bs in late February. That’s too late to avoid WS losses.

Many traders and tax preparers who are not well versed in the rules may leap to import 1099-Bs into tax software, but they will probably not comply with the laws for taxpayers.

We implore Congress and the IRS to address these structural conflicts in the wash-sale rules. I had hoped Congress would consider changes as part of tax reform discussions in 2017, but TCJA did not address these issues.

STRATEGIES TO AVOID WASH-SALE LOSSES ON SECURITIES

Consider keeping a “do not trade” list to avoid permanent wash-sale losses between taxable and IRA accounts.

For example, a trader could trade tech stocks in his individual taxable accounts and energy stocks in his IRA accounts. Otherwise, he can never report a wash-sale loss with an IRA, as there is no way to record the loss in the IRA — it’s permanent.

Taxpayers can “break the chain” on wash-sale losses at year-end in taxable accounts to avoid deferral. Suppose a trader sells Apple equity on Dec. 20, 2022, at a loss. In that case, he shouldn’t repurchase Apple equity or Apple equity options until Jan. 21, 2023, avoiding the 30-day window for triggering a wash-sale loss and breaking the chain.

Wash-sale loss adjustments during the year in taxable accounts can be absorbed if traders sell/buy those open positions before year-end and don’t buy/sell them back in 30 days. It means there won’t be a wash-sale loss deferral at year-end.

Consider a Section 475 election. Business traders qualifying for TTS are entitled to elect Section 475 mark-to-market (MTM) accounting, exempting them from wash-sale loss adjustments and the capital-loss limitation. Section 475 business trades are not reported on Form 8949; they use Form 4797 Part II (ordinary gain or loss). Although Section 475 extricates securities traders from the compliance headaches of Form 8949, it does not change their requirement for line-by-line reporting on Form 4797. We recommend trade accounting software to generate Form 4797. If a taxpayer elects Section 475, he will need that software to calculate the Section 481(a) adjustment, too. (Learn more about this adjustment in Chapter 2.)

Don’t trade securities. Trade Section 1256 contracts and other financial instruments not considered securities for tax purposes, like ETN prepaid forward contracts, cryptocurrencies, precious metals, and swap contracts. Only securities are subject to wash-sale loss adjustments.